Wall Street rallies amid rumours of AIG rescue

US stock markets rallied Tuesday as investors awaited signs of a possible rescue plan for the cash-strapped insurance giant AIG. Earlier in the day, European markets slumped to their lowest close since May 2005.

Bolstered by reports of a possible rescue of cash-strapped US insurance giant AIG, Wall Street rebounded Tuesday with the Dow Jones Industrial Average rallying 1.3% at the close.

In Europe, however, the main stock markets fell for a second day Tuesday, as investors waited anxiously to see whether the US government would grant AIG an emergency loan because the risk of letting it go bankrupt would be too great.

This would prevent AIG from suffering the fate of US investment bank Lehman Brothers, which filed for bankruptcy on Monday, sending shockwaves through the world’s stock markets.

European shares fell to their lowest close since May 2005, after markets slumped across Asia overnight. In London, the FTSE 100 index closed down 3.43 percent to 5,025.6 points. In Paris, the CAC 40 shed 1.96 percent to 4,087.40 points, and, in Frankfurt, the DAX shed 1.63 percent at 5,965.17 points.

Banks were the biggest losers, with UBS down 17.2 percent and Fortis down 11.5 percent in London. Meanwhile, Natixis bank shed 15.44 percent in Paris.

“For Wall Street and the financial markets, this is the worst crisis since the 1930s Great Depression,” David Wyss, chief economist at Standard and Poor’s, told France 24.

Central Banks to the rescue

To prevent markets from drying out of liquidities, the US Federal Reserve pumped 50 billion dollars into them Tuesday, adding to the 50 billion injected the day before. The Fed "stands ready to arrange further operations later in the day, as needed," a statement said.

But the Fed moved to hold its key benchmark US interest rate steady at 2%, dashing hopes that it would cut rates to give the markets and economy some respite.

Hours before, the Frankfurt-based European Central Bank (ECB) announced that it had provided 70 billion euros. It had already allotted an emergency 30 billion euros on Monday. The Bank of England and Bank of Japan also joined in the effort, with respectively 25 and 16.9 billion euros.

“The good news is that the economy in general seems to hold well against the crisis and this proves once again that the markets aren’t the centre of the economic world,” Wyss said.

Bringing back market confidence

New York Governor David Paterson warned Tuesday that AIG had one day to raise the 80 billion dollars needed to stave off bankruptcy.

Unlike Lehman Brothers, Merrill Lynch managed to find a buyer in Bank of America, which acquired the Wall Street giant Monday for $50 billion in stock.

The Wall Street Journal reported that a possible deal for Lehman's broker-dealer business would see at least 10,000 staff at the US group transfer to Barclays, the third biggest British bank, which has been discussing the possibility of buying some assets of the ailing investment bank.

Over the last two days, several of the world’s leaders, including US president George W. Bush on Monday, expressed confidence in the markets’ ability to bounce back.

"The answer to that of course is that we need to ensure that as far as we reasonably can, we get as much openness, banks declaring their positions, so that people can get certainty and therefore are more likely to put their money back into bank shares and so on," British Finance Minister Alastair Darling told the BBC on Tuesday.